Tuesday, May 1, 2012

Islamic microfinance: How is it different?

Kiva lends to thousands of entrepreneurs in countries where Islamic law impacts how people can borrow money and pay it back. Below, learn how Kiva's Field Partners approach these loans, which will be identified in loan descriptions going forward.

How is Islamic microfinance different?

Islamic banking was created as a separate path of financing in order to comply with prohibitions stipulated by Islamic law. Also referred to as Sharia law, Islamic law can be considered God's law as interpreted by Muslims.

Islamic scholars called Muftis in the Sunni tradition and Mullahs in the Shia tradition are charged with interpreting this law. The central texts of Sharia law are the holy book of the Qur'an, and the examples set forth by Muhammad and his early followers are documented in a collection of texts called the Hadith. To render a legal opinion, scholars weigh an action or principle against these texts and determine if it is in accordance with the spirit of the law.

Sharia law is very clear about charging interest on loans. The Qur'an forbids usury, or riba, in four different revelations based on the belief that money is only a medium of exchange and has no value in itself. Islam has not relented to pressures from the marketplace and has maintained its stance that charging interest on loans is usurious and a violation of Islamic law.

However, by differentiating trade from usury, the Qur'an reaffirms the practice of trading as a respectable profession. The importance of trading partnerships has motivated financial intermediaries to find creative ways to help Muslims access loans without violating Islamic law.

Some of Kiva's Field Partners that serve Muslim borrowers have created loan products based on Islamic principles to better serve their clients. These products have 0% interest and vary in design and delivery mechanisms. While some charge a service fee to cover the costs of administering loans, others share risk between lenders and borrowers or lease assets to borrowers (see next section for more details).

To certify that these products are compatible with Islamic principles, it is important for a microfinance institution to receive a fatwa, a legal pronouncement made by an Islamic scholar or religious leader, that officially condones its work.

Why does Kiva support Islamic microfinance?

The prohibitions against usury in the Qur'an are designed to protect weaker individuals from exploitation. Islamic microfinance attempts to capture the spirit of Sharia law by allowing financial tools that create and maintain a just economic system -- one that protects clients through built-in mechanisms like risk sharing.

Kiva believes in supporting products that are culturally compatible and designed to protect borrowers.

6) Salam: An advance purchase of goods delivered on a future date set by the buyer and seller.

7) Ijarah: Leasing of goods with a second contract to purchase them at the end of a lease period.

8) Joala: Payment of upfront fees.*

*How much are the fees associated with Islamic loans?

The fees associated with Islamic loans vary from one microfinance institution to another. As with all loans on the Kiva site, the best measure of fees paid by a borrower is the Portfolio Yield, displayed on borrower profile pages as well as Field Partner profile pages.

How is paying a fee on a loan different than paying interest?

For many Muslim borrowers, paying a fee on a loan is like paying a service fee on any other service transaction. Borrowers are purchasing the service of being provided with money. They pay a fee in the same way they would pay for consulting or advisory services.

When a borrower is about to receive a loan, he or she pays a fee to the microfinance institution before receiving the funds. In contrast, interest paid during the course of a loan is seen as money earned by the microfinance institution on the money itself, rather than a fee for the service.